The tendency of small-capitalization firms to have higher risk-adjusted stock returns than large-capitalization firms has been well documented in recent studies. Furthermore, these excess returns tend to cluster in the month of January. Attempts to explain this apparent contradiction to the Capital Asset Pricing Model have so far failed.

Most studies of the phenomenon have assumed, however, that the risk of small-firm stocks remains constant throughout the year. There is nothing in asset pricing theory that requires this assumption. If the risks of small-firm stocks do, in fact, increase at the beginning of the year, then their required rates of return should also increase.

Tests indicate that the market portfolio, as well as portfolios of small-firm stocks, have higher returns in January than in other months of the year. Furthermore, small-firm stocks have significantly higher total, systematic and residual risks in January than in the rest of the year. Thus the equilibrium rates of return investors require from small-firm stocks may be considerably higher (by eight to nine times, according to the 1963–82 evidence) in January than in the rest of the year. The “abnormal” returns on these stocks may not, after all, be abnormal.